Free Tax E-Filing System Defeated

California and the Internal Revenue Service have backed away from giving taxpayers free computer tax filing, bowing to opposition from private companies that make tax preparation software.

Instead, the tax collectors are compromising with the industry.

On Wednesday, the IRS announced that it has struck an agreement with a consortium of companies that typically charge a $10 to $30 fee to file taxes electronically. The IRS will refrain from establishing its own free online filing system. In exchange, the companies agree to offer free filing to at least 60% of taxpayers, with the mechanics to be worked out in coming months.

In California, where Intuit Inc. has led the industry’s effort by hiring lobbyists and making targeted campaign contributions, the private companies have successfully scuttled the Franchise Tax Board’s plans to offer a free, state-run Web site in which a computer does a taxpayer’s arithmetic.

An industry-supported bill that would ban an interactive state-sponsored electronic tax filing system is scheduled to be heard before a Senate committee Wednesday.

At both the federal and state levels, the tax agencies say they are simply trying to give people a quicker, easier way to file with the government and eliminate long lines at the post office before midnight on April 15.

Makers of tax preparation software call the government effort unwarranted competition.

“We expect this [IRS] proposal will greatly increase electronic tax filing,” said Ed Black, president of the Computer & Communications Industry Assn., which represents software makers and Internet and telecommunications companies. “A huge percentage of that will be free and it will be done by companies that have already invested a lot in making sophisticated, sharp, intelligent software.”

IRS Commissioner Charles O. Rossotti called it “another significant step in the government’s e-filing effort.”

The debate in Sacramento and Washington, D.C., is the same. Tax agencies say they are not competing with private industry because their free filing systems would provide only arithmetic capability and a scan of tax tables, and would not advise people how to fill out their returns.

“It’s basically a form with some links to some instructions that does the math,” said Harley Duncan, executive director of the Federation of Tax Administrators. “It’s not: ‘Did you think about deducting the steel-plated safety shoes?’ ”

But the tax preparation industry objects for competitive reasons and, representatives say, because of concern for taxpayers’ privacy. They point to troubles this spring in England, where the government’s electronic tax system was shut down after people reported being able to view strangers’ tax data. In California, taxpayers can connect through the Franchise Tax Board Web site to nearly a dozen companies that offer electronic filing. That includes Intuit, which offers free use of its TurboTax program to people who earn less than $25,000 a year. But Californians cannot do their taxes directly through the tax agency’s computer site, as taxpayers can in several other states.

In Missouri, where lawmakers killed a bill that would have banned the state from establishing e-filing, the number of people using the state’s “WebFile” system grew 53% in its second year.

California tax officials say that of the 13.5 million state tax returns filed so far this year, 3.1 million were filed by computer. Of those, 2.4 million were handled by professional tax preparers. An additional 700,000 residents used private electronic filing services.

State Controller Kathleen Connell, who wields great influence over the progress of electronic tax filing as chairwoman of the Franchise Tax Board, calls the current battle with the computer industry a “trench war.”

Mountain View-based Intuit has spent $400,000 since 1999 lobbying the board and lawmakers. The company and its executives contributed $75,000 to Connell, including $10,000 for her unsuccessful run for mayor of Los Angeles in 2000.

Connell has pushed the Franchise Tax Board staff to find a way for the 4.3 million Californians eligible to use the state’s simplest tax form, the 540 2EZ, to file by computer. They can already file by punching digits on a push-button telephone.

Franchise Tax Board Executive Director Jerry Goldberg said Connell appeared to be pleased in January when he showed her a demonstration Web site that calculated state income taxes for residents using the “2EZ” form and allowed them to file directly to the agency for free.

“We were set to move forward,” he said.

But Connell halted progress at Franchise Tax Board meetings in March.

She said she did so because of the privacy concerns of state Sen. Steve Peace (D-El Cajon) and Assemblyman Bob Hertzberg (D-Van Nuys). Intuit has not contributed to either lawmaker since 1999.

Peace said he fears that state tax auditors will track people’s keystrokes as they fill out their tax forms on the computer, then target those who make many changes.

“I don’t want all the work I did to get to the final product to be in their hands,” said Peace. “I don’t want auditors to go back and say, ‘Here’s a guy who took three tries at filling in his income.’ ”

Franchise Tax Board spokesman Pat Hill acknowledged that there is technology that allows a tracking of keystrokes.

“But why would we do it?” he said. “We’re interested in collecting the final tax return that they transmit to us.”

In March, Connell met with representatives of several electronic tax filing companies, including Intuit. They struck an agreement, later approved by the entire Franchise Tax Board, under which the state will not provide math calculations or tax table searches for electronic filers. Instead, taxpayers must download a form, print it out, use a pen and calculator to fill in the form, then log back in, enter the data and hit “send.”

The board is prepared to launch such a free system in September, according to Connell’s office.

Lenny Goldberg, a lobbyist for the California Tax Reform Assn. and the Privacy Rights Clearinghouse, criticized the system as clunky.

“You shouldn’t prevent taxpayers from pulling up the form and filling it out, having the computer do the math and look up the tax,” he said. “You shouldn’t have to pay to file your taxes.”

A bill pending in the Senate Revenue and Taxation Committee, AB 2781 by Assemblywoman Rebecca Cohn (D-Saratoga), would limit the state’s electronic filing capability to a system like that in the agreement struck by Connell with private industry.

“I don’t think the arithmetic is the key here,” Connell said. “The key here is to get people to file electronically, with or without the arithmetic.”

But others in California say they want the state to operate its own free electronic tax filing, regardless of what the IRS does--or what private industry wants.

“This industry doesn’t need to be in the game for a lot of tax filers,” said state Sen. Joe Dunn, (D-Santa Ana), whose bill last year to require state sponsorship of e-filing was killed by industry opposition. “For the person who prepares a simple form, they really don’t need Intuit or H&R; Block.”

“We ought to set up an e-file system that is consumer-friendly,” said Dunn, “and I couldn’t care less if the industry is happy about it or not.”

Times staff writer Virginia Ellis contributed to this report.